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We're Castaways in a Sea of Finance By Stephen J. Butler

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Recent events in the financial world illustrate how difficult it is to access objective, unbiased financial advice. There are no simple answers to our complicated needs. To make matters worse, there is no one to help us whose interests are 100% aligned with ours. In the end, we are our own best counsel, and there is no substitute for a mix of education and healthy skepticism.

How do I support this contention? Let's start with fifteen year old Jonathan Lebed in New Jersey who, starting with proceeds of an $8,000 savings bond, made $800,000 in six months. Obsessed with the stock market, he researched companies extensively and even had his mother drive him around to various corporate headquarters to see if they really existed. After he came in fourth in a national stock-picking contest of high school students, his home page had over seven hundred people hitting the sight for his stock tips.

At some point, he learned that the prices of thinly-traded stocks could be influenced positively when even a relatively small group of investors were bidding up the price. The prices of stocks, remember, are determined by what stock traders buying and selling on a given day happen to be bidding and asking. If relatively few shares in a small company are offered for sale, and someone is anxious to buy, the price can rise dramatically. The price of the last transaction determines what all stock in the entire company is worth at the end of that particular day, and this practice is referred to as "marking to market."

Well, Jonathan described in enthusiastic tones the future, as he saw it, for the stocks he was purchasing. On some days, he would register his beliefs on as many as 200 different web sites. In many of these postings, he was simply paraphrasing the jargon of Wall Street analysts. His web site postings offer a parody of Wall Street analysts.

An article by Michael Lewis in the New York Times Sunday Magazine last February 25th offers a wonderfully readable chronicle of what happened next. Truth is stranger than fiction. The Securities Exchange Commission (SEC), formed in the 1930s to protect the public against stock manipulation, called Jonathan and asked that he report to their New York offices. In the end, after a lot of wrangling, they made him pay back about $200,000 of the $800,000. What about the other $600,000?

The other $600,000 managed to get some traction on that vast slippery slope of self-interest versus integrity that makes up the industry's self-policing effort.

Earlier this year, in New York, a pediatrician sued Merrill Lynch's internet analyst, Henry Blodget, for losses and punitive damages totaling $10 million. Mr. Blodget had been promoting JDS Uniphase and InfoSpace which have both plummeted. The suit contends that what Mr. Blodget did not disclose was that Merrill Lynch was the investment banking advisor for a purchase of InfoSpace by Go2Net. The purchase, which would have generated a huge fee to Merrill Lynch, required that the stock price of InfoSpace remain above a certain level, and this may have colored Mr. Blodget's thinking. FORTUNE recently covered a story about an analyst who had been fired for opinions that stood in the way of his employer's investment banking business. The article triggered a flood of letters from readers sympathetic to the analyst.

In theory, the investment banking world is now supposed to maintain a "Chinese Wall" separating the information between investment banking and securities sales departments. Years ago, however, I was riding up a ski lift with a Wall Street banker who said that a colleague, who later went to jail along with Ivan Boesky, once told him that he was never sorry that a merger involving a major automobile parts manufacturer never went through. He had made millions trading the stock on the rumor that he had created by the proposed merger activity. Meanwhile, a business school classmate of mine, working for a regional brokerage firm in San Francisco years ago, quit his job when the managing partner seized from everyone's desk an analyst's report urging a "sell" on a Bay Area stock the firm had taken public.

This time it's different? I don't think so. In the news this year was "Tokyo Joe," a burrito store owner who settled his case with the SEC by paying $754,630. He had been practicing the same behavior as Jonathan Lebed, but to Jonathan's credit, Mr. Yun Soo Oh Park had been charging 4,000 clients as much as $600 per month for advice. Unfortunately, he was practicing the advice himself before offering the stock picks to clients. This is clearly illegal. While 4,000 people were paying him for advice, he claimed that he was not an investment advisor (as defined by the SEC) but was simply exercising his right to free speech. In the new economy, which includes people chatting all over the web, Mr. Park enjoyed at least a toe-hold of rationale for his behavior. This has probably kept him out of the slammer while it prompts law school classes to revisit First Amendment rights.

Meanwhile, some mutual funds encourage their analysts to invest in the companies they recommend and other fund families forbid the practice. We can argue that someone should put their money where their mouth is. On the other hand, we have nothing more than a large scale version of the practice that got "Tokyo Joe" and Jonathan Lebed into trouble.

What's the SEC to do? In a difficult world where lines are clearly blurred, it is a Herculean task to determine what is for or against the public interest. Is the glass half empty or half full? We read about our regulatory bodies and the extent to which they have failed to prevent an abuse from taking place. On the other hand, we have what is arguably the world's most "squeaky-clean" financial marketplace. Japan's, by comparison, just reeks with self-dealing behavior that has driven their public away from equities markets. This, combined with a hopelessly corrupt political system, is a major factor in the stalled recovery of their economy.

Regulatory action is an important deterrent to illegal activity. Most financial services professionals do not want to spend time in jail or even court. When arresting a white collar suspect, the FBI has a practice of sending four agents for each alleged perpetrator because the strength in numbers helps avoid a scene. Years ago at Kidder Peabody, the Feds made a point of slapping handcuffs on everybody they escorted from the building. People who give to the opera and make upwards of $1,000,000 a year think first before exposing themselves to the potential for that level of humiliation.

As Teddy Roosevelt said, "Speak softly and carry a big stick." Thanks to our regulatory bodies, we have a reasonably level playing field upon which to invest, but getting objective advice is sometimes a struggle. Continue to absorb as much financial education as possible and search, through friends and referrals, for a good financial planner, money manager or broker if you feel you need additional help. Never hesitate to ask tough questions of anyone with whom you choose to work. On at least some level, those of us who act on bad advice have only ourselves to blame.

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